78 Stocks Doubled Year-to-date

All stock charts in this post are powered by MarketSmith.

I ran a MarketSmith screen to see how many stocks priced above $5 and trading at least 100k shares a day, doubled year-to-date. The result: 78.

One can easily assume that most of those stocks probably belong to very profitable companies. I applied an earnings quality filter. It turns out that only 6 out of the 78 stocks are in the top 20% in earnings quality. This should challenge the common-held belief that earnings growth is the driving force behind strong price performance. The market is a lot more nuanced and complicated in a one to twelve months perspective. Expectations for future price gains drive demand and supply in the short-term and nothing impacts those expectations more than recent price action. Price momentum continues to be one of the least understood and most powerful characteristics behind many of the best-performing stocks every single year.

The Most Profitable Business

All stock charts in this post are powered by MarketSmith.

Kylie Jenner might be the youngest self-made billionaire in the history of the world. She is not even 21 but she has managed to leverage her social media following and Internet tools like Shopify to build a highly profitable business. She sells makeup. Her company Kylie Cosmetics has generated more than $600 million since its launch two years ago. Forbes has an interesting overview of her business.

What interests us more as investors is how we can participate in this high-margin, high-growth makeup business? There are several cosmetic plays available to public investors – ULTA, ELF, AVP, LVMUY (which owns Sephora).

The price action in ULTA is the only one that is catching my attention at this point. After going from $5 per share in 2009 to $300 in 2017, ULTA has pulled back about 20% and it might be setting up again.

ULTA is not just a pure momentum play. No long-term trend can survive on just rising market expectations. Long-term price appreciation requires serious earnings growth. And ULTA has the numbers. ULTA had earnings per share of 1.90 in 2012. This year, it is expected to make 8.40. In 2020, it is anticipated to gain close to $13 per share. It is currently trading at about 20X its 2020 expected earnings, which is a reasonable valuation for a company that grows 30% per year.

ULTA is working on a new base and it needs some time to set up properly. A breakout above $260 might trigger another momentum move higher. I don’t own any shares of it at the moment.

About GE and the 52-week Low Rule In A Bull Market

Charts in this post are powered by MarketSmith.

GE has just lost its spot on the Dow 30. Walgreens will replace it. This should not come as a big surprise. Its stock has been in a disarray for quite some time. It is down about 60% for the past 18 months.

You would not believe how many people told me they were buying GE at 25, 20, 18, and 15 because “it has become very cheap and it will come eventually back”. Maybe, it will recover to all-time highs one day. Maybe, it will take many years to do so and you will get tired of waiting.

Not all individual stocks recover from a big drawdown. Many remain dead money for decades to come. There is a big difference between individual stocks and stock indexes.

Indexes usually come back because they are diversified and they cut the losers (remove stocks which market cap has fallen below a threshold level) and add potential winners (add stocks which market cap has risen above certain threshold level). The current minimum threshold for the S&P 500 is $6.1 Billion.

The most popular stock indexes in the U.S. are basically long-term trend following systems in disguise. I sometimes joke with passive investors (indexers) that they are actually trend followers who don’t want to pick stocks.

Buying 52-week lows in a bear market is understandable if you are a value investor. Most stocks take a big hit during market corrections and the good is thrown out with the bad.

Buying stocks making 52-week lows in a raging bull market is a completely different story and it often doesn’t end well. If a stock keeps plunging while the rest of the market is advancing there’s is usually something very wrong with it and it is likely to continue lower. You can save yourself a lof headaches if you ignore the 52-week low list during bull markets.

Most people will be better off waiting for a beaten-up stock to build a new base and break out to new 52-week highs before they enter. A new 52-week high in a crushed stock might still mean 50% below its all-time highs.

When you buy a new 52-week high in a heavily neglected stock, you achieve two things: you have momentum on your side and you have plenty of people who don’t believe in the stock, which is good because those same people are a future source of demand.

Why Momentum Investing Is A Contrarian Approach

Charts in this post are powered by MarketSmith.

The two biggest errors in bull markets are usually errors of omission. Not buying a stock because it is up too much too fast or not buying a stock because you sold it at a lower price recently.

If you bought something at 10 and sold it at 14, the odds are that you are not going to buy it back at 20. Even if the new setup looks incredible, it will be like chasing to most. This is why momentum investing is a contrarian approach and it continues to work. It seems easy only in hindsight, but it is never so when you have to apply it in real time.

People need time to adjust to new prices. When a stock goes from 40 to 160, it seems extremely expensive to everyone. It takes spending a considerable amount of time in that new price range, for people’s mental model to change. This is why many momentum stocks build new bases after a considerable recent run.

The typical momentum stock goes through 3 distinct stages:
1. Price leads – expectations for a brighter future attract buyers and a company price appreciates very quickly mainly because of a P/E expansion. The market is willing to pay a higher price for the expected earnings. FOMO (fear of missing out), short squeezes, and the overall market sentiment also have a big impact. An optimistic market might be willing to pay several times higher price than a pessimistic market for the same earnings growth.
2. Price spends some time in a range while earnings growth catches up with the market expectations. The market made a bet for a brighter future in stage one and now the company needs to prove the market right by delivering strong earnings growth. If a company fails to meet the market’s high expectations, its stock might quickly decline 50% or more.
3. Price growth and earnings growth go hand in hand.

NVDA might be a typical example. It had a huge run in 2016-2017. It seemed expensive all the way from 40 to 200. Then, it spent 6 months in a range and now it is setting up again near its all-time highs. $300 is very possible scenario by the end of 2018.

Disclaimer: everything on this website is for informational and educational purposes only. The ideas presented are not recommendations to buy or sell stocks. The material presented here might not take into account your specific investment objectives. I may or I may not own some of the securities mentioned. Consult your investment advisor before acting on any of the information provided here.

About that Silly “There Are No Good Trading Books” Argument

Traders who are considered successful are often asked the question – “What Trading books do you recommend?”. I am often stunned to hear some of them saying that there are no good trading books.

The reasoning that there are no useful trading books is ridiculous. It comes from people who don’t have the patience, the time, or the skills to create a good book – it takes hundreds of hours of dedicated deep work. The difference between writing and reading a book is the difference between growing and eating an apple.

“If it is that good why are you sharing it” is the silliest argument. Writing a book about any subject makes you think long and deeply about it. It encourages and requires you to experiment, read, compare, study, write. At the end of the process, you learn a lot more about yourself and about the subject.

The statement that “no trader will share a working method” doesn’t hold water. It is one thing to read about a subject and completely different to be able to practice it properly. Watching a Bruce Lee movie doesn’t make you a martial arts expert. Knowing what it takes to get in a great shape (proper diet and exercise), doesn’t mean that it is easy to achieve it.

If you are too lazy to learn from other people’s perspectives, nothing is going to change your mind.